This Selected Issues paper on Turkey describes the link between budget deficits and inflation. The paper outlines the key elements of the recent reforms and additional measures to reform the system. The study assesses the impact that inflation has had on the banking system, examines the sources of volatility of Turkey's external balance, and presents empirical estimates of the elasticities governing the behavior of exports and imports. The paper analyzes the costs of agricultural support policies along these methodological lines, and also provides a statistical appendix for the country.

V. How Costly Are Agricultural Support Polices to the Taxpayers: A Methodological Primer?56

119. In the mid-1980s, Turkey made an important shift in its agricultural policy. Earlier, the country’s agricultural policy, similar to that in many other developing countries, essentially taxed agricultural commodity exports and subsidized agricultural imports.57 This offset a large part of the support that was given to the sector in the form of subsidies to various inputs, yielding an overall level of support that was kept low. In the mid-1980s, producer price supports, complemented by trade measures, were introduced and later intensified, contributing to a significant increase in the overall support provided to the sector, and consequently its cost. The OECD review of Turkey’s agricultural policies58 estimated that total support (as measured by the percentage producer subsidy equivalent59) rose to 40 percent in 1991–93, double the rate in the period 1979–81.

120. Much has been said about the inefficiencies of such policies. In particular, these policies are not giving Turkish farmers the flexible and clear price signals that are needed for them to respond efficiently to changes in demand. The country is a net exporter of heavily supported commodities, such as cereals and sugar, but is importing increasing amounts of other commodities, such as dairy products and beef, where the country may have a genuine comparative advantage. As a means of boosting agricultural productivity and food production for a growing domestic market, these policies have been largely self-defeating.60 Indeed, the self-reinforcing nature of support policies is likely to be the main obstacle to removing major impediments to higher productivity, namely small farm size, continued fragmentation of holdings, and a poorly trained workforce. Support purchases as well as input subsidies are effectively open-ended, benefiting rich farmers more than poor ones, and hence are a poor vehicle for alleviating rural poverty. Moreover, in the absence of a clear link between support prices and world market prices, and between subsidized credit interest rates and market interest rates, these policies have led to a loss of state control over their costs.61

121. However, very little has been said about the nature and the magnitude of the direct fiscal costs of agricultural support policies, and a great deal of confusion reigns in the debate about these issues, both in academic and in political circles.62 This state of confusion is mainly the result of the lack of transparency in the way these agricultural support policies have been administered. The share of these costs that is reflected in the central government budget is shrinking, whereas the remaining ballooning share is spreading across the many layers of the public sector. The government is giving so-called “duties” to some State Economic Enterprises (SEEs) and Agricultural Sales Cooperatives and their Unions (ASCUs) to execute certain support policies on its behalf. Theoretically the state is supposed to compensate these entities for the cost they incur. Usually, though, the amount of compensation provided each year is dismal, leaving it to these entities to find financing to cover these costs.

122. This kind of arrangement creates two problems. First, the task of adding up the bits and pieces of costs becomes quite complex, not only because these costs are spread across many accounts but because of the structure of their financing. Some of these costs—those incurred by the SEEs—are financed through inter-enterprise arrears, tax arrears, and arrears to the social security institutions, with sporadic one-time write-offs of debts, and the assumption of the debt by the treasury. Second, and much more importantly, the available measures of the costs outside the central government’s budget reflect both the “original” cost of the policies plus the cost of servicing the “debt” that has been incurred to finance the initial cost, such as interest penalties on tax arrears, or the cost of carrying large stocks of unsold surplus production in the form of interest payments on the debt that was incurred to purchase this surplus production. Such cost of servicing the debt, while related to agricultural polices, does not involve transfers to farmers. On the other hand, there are some transfers to farmers (those from consumers due to higher domestic prices of agricultural products) that do show up the fiscal accounts. This chapter disregards those costs, focusing on the fiscal impact of agricultural policies.

123. A proper understanding of the fiscal costs of agricultural support policies has to make a clear distinction between the “primary” cost of these policies and the component of the cost that simply represents the burden of accumulated debt. This distinction is important when it comes to making policy recommendations for the reform of agricultural support policies. Clearly, the fiscal savings that can be achieved through a reform of the agricultural policies per se can only be realized from cuts in the primary component of the cost. The remainder cannot be affected by reform of agricultural policies, and will only decline to the extent that there is a fall in real interest rates, and/or a reduction in the debt stock through sales of accumulated excess stocks.

124. The chapter seeks to quantify and analyze the costs of agricultural support policies along these methodological lines. Its results are preliminary, as is the methodology used to derive them. Nevertheless, the results suggest that while the total cost of agricultural support policies has averaged about 5 percent of GNP during the last five years, the primary component accounted for a smaller and declining share, while interest payments have accounted for a larger and increasing share, as real interest rates increased and the stock of liabilities grew. At 2 percent of GNP in the last three years, the primary fiscal cost of agricultural support policies in Turkey is lower than has generally been thought.

125. The rest of the chapter is organized as follow. Section A makes a brief assessment of the cost of input subsidies. It shows that the cost of fertilizer and other raw material input subsidies is easy to measure as these subsidies have been covered directly from the budget. In addition, the cost has declined quite sharply over the recent years and, at 0.2 percent of GNP in 1999, has become a negligible component of the total cost. The cost of credit subsidies is more complex to assess and a methodology is developed to analyze it (as explained in Chapter I). It is shown that the primary component has gone down quite sharply in recent years while interest payments snowballed. The total cost reached 5 percent in 1999. Section B analyzes the costs of the price support system. This is the component of the cost which is the least transparent and requires an in-depth look at the accounts of the main agricultural SEEs to disentangle the primary component from the overall costs. The section shows the link between a measure of these costs computed by the SEES/treasury, which is called unpaid duty losses, and the borrowing requirements of the SEEs. The section finds that the overall cost of the price support system has increased from less than ½ percent of GNP in 1995 to 2 percent in 1999. Over the last three years, the primary component of this cost has been about half.

A. Cost of Input Price Subsidies

126. The cost of fertilizer subsidy, provided on an unlimited per unit basis, is the main component of the input subsidy cost. Prior to 1997, the subsidy was an ad valorem amount paid to farmers upon presentation of payments receipts. The system was then changed and the subsidy is now provided directly to producers, with farmers paying the subsidized price at the point of purchase. This cost has been halved to just 0.15 percent of GNP since 1996, after the subsidy per kilo has been frozen in nominal terms at end 1997. Various small subsidies also exist for seeds, pesticides, and milk production. Together they amount to less than 0.03 percent of GNP.

127. As explained in greater details in Chapter I, the cost of credit subsidy up until around 1994–95 was born by Ziräat Bank and covered by its own profits. After than, and as a combined result t of a decline in Ziräat’s profits (due to a loss of market share) and a widening of the wedge between Ziräat’s cost of funds and the subsidized rate at which it was lending, the cost was covered by an accumulation of claims on the government (the so-called unpaid duty losses), the yield of which was de facto set so as to cover any loss accumulated. Also as explained in Chapter I, the accumulation of unpaid duty losses, which to a great extent could be attributed to the credit subsidies to farmers,63 can be decomposed into a primary component and a debt burden component. A possible measure of the primary component was presented in that chapter and is used in Tables 1 and 2.

B. The Cost of the Support Price System

128. The number of commodities for which support purchases are made has varied widely. It grew rapidly to 30 in the 1980s, was later reduced to 11 by the early 1990s and grew back to 19 by 1999. Only three main crops (cereals, tobacco, and sugar beet) are officially supported, the rest are “unofficially” supported.64 Support purchases of the officially supported commodities represented, in 1999, 60 percent of total support purchases. Support purchases of unofficially support commodities (with the exception of tea) are done by ASCUs and are not automatic. Each year the ASCUs must apply for authorization to commission them.

The cost of support purchases done by the ASCUs

129. The fiscal cost of support purchases done through the ASCUs is captured by the component of the budget allocation to the support price stabilization fund for agricultural support.65 These funds are channeled to ASCUs (and sometimes to agricultural SEEs) in the form of subsidized credit. ASCUs have never repaid these loans and the outstanding stock of credits keeps increasing by the additional budget allocation every year. This is why the entire budget allocation could be regarded as the cost of supporting the industrial crop purchased by these ASCUs. This cost is reflected in line 1.4 of Tables 1 and 2.

The cost of support purchases done by the SEEs

130. The cost of support purchases done by the SEEs is the hardest one to analyze and quantify. To prepare the ground for such an analysis, it is useful to first start by presenting the two measures of this cost that are the most commonly used. For the Turkish Grain Board (TMO)—engaged in cereal support purchases, the Turkish Sugar Factories Inc. (TSFAS)—engaged in support purchases of sugar-beet, and the Tea Industry Corporation (Caykur)—engaged in support purchases of tea, the first measure of the fiscal cost is their total deficit as reflected in their financial statements. For the Directorate General for the Tobacco and Tobacco Products, Salt, and Alcohol Industry (TEKEL), the financial statement of this SEE consolidates the activities of its support agency and its “regular” cigarettes and alcoholic beverages production, and thus cannot be as readily used to measure the cost of the support activities. The second measure of the cost of support purchases is what these companies report as their “duty losses.”66

131. To understand both measures and the link between them, the following stylized presentation captures the way these two measures are computed in the case of TMO. Tables 3 and 4 show the data for TMO and TSFAS.

2/Includes sales to domestic candy producers done at same prices as exports.

3/An approximation of the financial deficit is given by the difference between the revenues from sales minus the cost of the goods sold minus the change in the value of the stocks.

4/Duty losses are calculated as the volume of exports tunes the difference between this unity ear cost of production and the export price.

5/Includes additional payments like transportation and stocking fees.

6/Before budgetary transfers. Differs from the one calculated above as it include some other expenditures which are excluded for the stylized calculation presented above.

7/Lower than those calculated above because they deduct partial payments received from the treasury.

1/About 8 tons of sugar beet are needed to produce 1 ton of sugar.

2/Includes sales to domestic candy producers done at same prices as exports.

3/An approximation of the financial deficit is given by the difference between the revenues from sales minus the cost of the goods sold minus the change in the value of the stocks.

4/Duty losses are calculated as the volume of exports tunes the difference between this unity ear cost of production and the export price.

5/Includes additional payments like transportation and stocking fees.

6/Before budgetary transfers. Differs from the one calculated above as it include some other expenditures which are excluded for the stylized calculation presented above.

7/Lower than those calculated above because they deduct partial payments received from the treasury.

Let Q0 be the stock of grains at the beginning of the year, whose value has been booked in liras at S0,67

Let Qp be the volume of new purchases during the year and Cp the cost of these purchases,

Let F be the financial charges on the stock of debt,

Let TC = So + Cp + F be the total cost of the quantity Q0 + Qp.

Assume a quantity Qs is sold during the year with sales proceeds equal to R.

TMO’s accounts define the cost of goods sold Cs as equal to (Qs/(So + Qp))*TC, i.e., the total cost prorated by the fraction of the volume, which will be sold during the period. The value of the stock at the end-of the period (Q1 = Q0 + Qp – Qs) is booked as the remaining component of the total cost, i.e., S1 = TC – Cs.

TMO defines it duty losses Dl as equal to Cs – R, the cost of the goods it sells minus its sales revenues.

Its financial statement will instead show a deficit Df equal to S1 – So + Cs – R, change in the value of stocks plus the cost of goods sold minus the sales revenues.

In this set up the link between the deficit as reflected in the financial statement and the reported duty losses is then:

132. As can be seen in equation 1, in years where there is an accumulation of stocks, the deficit will record a cost higher than the one measured by the duty loss. This is the case because the increase in volume combined with inflation is guaranteeing that S1 ≻ S0. In years where there is a de-cumulation of stocks the deficit may be lower than the duty losses but not necessarily. This is because the “valuation gain” may offset the decline in volumes. The “valuation gain” arises from the fact that the value of the stock at the end-of-the period reflects both a historical value but also the cost of the new purchases which is usually increasing in line with inflation.68

133. To determine to what extent these measures could be used in assessing the cost of these policies, it is important to review first what, theoretically, the main primary cost of a price support system complemented by trade measures is (what we could call an” an export subsidy cost”). This is illustrated by the following simple model:

Let SS be the domestic supply curve and DD the domestic demand curve. Let P* be the international price. In the absence of trade barriers and price support, the domestic price would be equal to the international price. The country is a net importer of that commodity. A quantity OQ1 would be produced domestically, a quantity Q1Q2 would be imported, and the total quantity OQ2 would be consumed. The price support policy consist in introducing a support price at a level of say, Ps, and complement this policy with a trade measure in the form of a tariff τ such that P*(1 + τ) = Ps. With this policy, the country instead of being a net importer becomes a net exporter of that commodity. A surplus production Q3Q4 is generated. If it is exported, a loss equal Q3Q4 * P*PS will be incurred. The higher the support price compared to the international price the higher is the surplus production and the higher the implied fiscal cost.69 Note that the cost comes only from export activities or stock building, not from domestic sales. Domestic prices to the local consumers are always a certain margin above the support price (but see footnote 15 below).

134. Of course, the excess production Q3Q4 is not always exported within the same crop season. Two considerations are taken into account in deciding the timing and the amount of exports. The first consideration is the appropriate level of food reserves that have to be kept for strategic food security reasons. Because of such consideration, the authorities may decide to use some of this excess production to permanently build strategic grain reserves. The higher the stock of reserves, the higher is the interest burden that the public sector has to sustain. The second consideration has to do with choosing the right foreign market conditions for selling stocks. When international market prices are too low and there is an expectation that they will go up in the future, a decision could be taken to postpone exports. In both cases, the primary component of the subsidy is given by the rectangular area Q3‘Q4’Q3“Q4”, that is, each year, the amount of purchases net of domestic sales times the difference between domestic price and international price. In the case of tobacco, given the low quality of the surplus production and the expendability of such stocks, surplus production has often had to be burned.

135. This methodology is used to analyze the primary fiscal cost of the price support, as illustrated in Table 5, and summarized in Table 6. The results are preliminary and would need to be firmed up based on more refined data. As can be seen in Figure 1, the total primary cost has increased from about US$700 million in 1995 to US$ 1,800 million in 1999 (about 1 percent of GNP)70 reflecting the overall trend of widening spreads between support prices and international prices resulting from high and sometime increasing support prices in the face of sharply declining international prices. This trend has, in addition, been accompanied by a trend accumulation of stocks leading to an increased debt burden.

Table 5.Turkey: Computation of the Primary Cost of the Support Price System for Cereals and Sugar(In trillions of Turkish liras, unless otherwise specified)

Figure 1.Turkey: The Primary Fiscal Cost of the Price Support System, 1995–99

136. In particular, during the last five years, the export subsidy cost of supporting cereals has gone up due to a widening of the gap between support prices and international prices. This gap which, for wheat, narrowed down to less than US$15 per ton in 1996, widened to close to US$80 per tons, due to the small adjustments of support prices in the face of sharply declining international prices (Figure 2)71 In the meantime stocks have build up reaching some 6 million tons. The primary cost has averaged about US$200 million over the last three years, some 0.1 percent of GNP.

Figure 2.Turkey: The Grains Sector, 1995–99

Source: Data provided by the Turkish authorities.

137. For sugar, the same trend as for cereals has evolved in recent years. The support price for sugar beet has increased very sharply since 1994, at a time when international prices where fallen.72 Stocks built up reaching 2 million tons. TSFAS produced an average of 1.6 million tons and had to export an average volume of 240 thousand tons,73 at an average spread of close to US$500 million. The average export subsidy is estimated at US$220 million, less than 0.1 percent of GNP (Table 5).

138. Based on these estimates the total cost of the price support system could be measured by the deficit of the SEEs, while the debt burden element of these costs could be derived as a residual after subtracting the estimate we derived for the export subsidy. This approach, however, underestimates somewhat the primary component because it is based on the assumptions that no losses are incurred on domestic sales. In practice, in recent years, the profile of the domestic sales price within a crop season has not always fully covered the intra-harvest storage costs. Because of that an arbitrage opportunity was left open to traders of delaying their purchases and obliged TMO to buy a larger share of the harvest than it would have otherwise.

139. The results of the methodology developed above are presented in Table 1. These numbers are mainly illustrative of the methodology and would need to be refined in light of more accurate and detailed information. The table shows that the overall cost of the price support system, the sum of the deficits of the SEEs plus the budget allocation to SPSF, as has increased from less than ¼ percent of GNP in 1995 to 2 percent in 1999. Over the last three years, the primary component of this cost has been about half.

1/Data on capacity utilization are collected from monthly and quarterly surveys. The quarterly series is based on a larger sample, hence it is not directly comparable with the monthly series. The annual figures in this table are averages of the quarterly data.

2/Provisional.

Source: Data provided by the Turkish authorities.

1/Data on capacity utilization are collected from monthly and quarterly surveys. The quarterly series is based on a larger sample, hence it is not directly comparable with the monthly series. The annual figures in this table are averages of the quarterly data.